The determinants of bank failures: a survey of commercial banks in Kenya

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This paper examines the determinants of bank failure in Kenya over a period of five years between 1998 and 2005 using capital adequacy, asset quality and earnings after tax are cited as major predictors of bank failure. Ratios used to measure capital adequacy, asset quality and return on assets have shown to be suitable predictors of bank failure. This study addresses the determinants of commercial bank failures in the banking industry.
Data from 21 commercial banks was obtained and analyzed using SPSS package. Kenya’s banking industry looked shaky but is currently stabilizing. Key ratios like capital adequacy, asset quality and return on assets did not have a consistent trend and this was worrying. It showed that banks’ management did not have clear policies on how to maintain and grow these key ratios. Looking at individual bank may not be a strong relationship that certain variable highly affected bank failure.
The study showed that bank failure has no significant relationship with earnings after tax, total loans, total equity and return on assets. However, bank failure has a significant relationship with capital adequacy, asset quality and total assets. Asset quality was the most critical aspect that affects bank failure but capital adequacy and total assets also affected the predictability of a failure in a commercial bank. Total assets influenced the relationship between the asset quality with bank failure and increase in capital adequacy will accelerate the chances of bank failure. A decrease in total assets will increase the capital adequacy ratio and hence increase the chances of bank failure.
Over the last decade, national and international regulatory bodies, in an attempt to lessen the chance of a bank failure have imposed stricter requirements on capital adequacy and asset quality. This study addresses the imbalance by developing an approach to measure the benefits of capital adequacy, asset quality, total loans, total assets and return on assets to curb the bank failure and adopt the desired levels for all the variables that influence bank failure.